Has Pandora Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Pandora fits the bill.

The quest for perfectionStocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.

Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.

Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.

Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.

Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.

Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Pandora.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

99.8%

Pass

1-year revenue growth > 12%

59.3%

Pass

Margins

Gross margin > 35%

32.3%

Fail

Net margin > 15%

(8.3%)

Fail

Balance sheet

Debt to equity < 50%

0%

Pass

Current ratio > 1.3

1.97

Pass

Opportunities

Return on equity > 15%

(29.9%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current yield > 2%

0%

Fail

5-year dividend growth > 10%

0%

fail

Total score

4 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.

Since we looked at Pandora last year, the company has dropped a point, as gross margins fell considerably. The share price has also left much to be desired, falling about 15% over the past year.

Pandora has made big strides forward in the Internet radio space, with 2012 proving to be another big year for revenue growth at the company. Yet profitability continues to elude Pandora, in large part because of the incremental costs of providing music to listeners that are only likely to keep rising in the years to come.

The scariest threat for Pandora investors lately has been the prospect of competition, and rivals are definitely weighing in. Sirius XM came out with a beta version of its own personalized radio platform in January, and with its already-impressive subscriber base of nearly 24 million customers, Sirius could displace a large number of potential Pandora users. In the longer run, an offering from Apple could prove even more disruptive, as Apple already has huge relationships with music labels that will make it easier for the iDevice giant to negotiate favorable deals at lower content costs than Pandora pays.

With that in mind, Pandora is taking a big gamble, capping its free streaming option at 40 hours per month. Above that, the company will charge $0.99. The move is trying to get more users to subscribe to the $3.99-per-month Pandora One premium service, which offers an ad-free listening experience, but users have been reticent in the past even to pay that modest fee.

For Pandora to improve, it simply has to find a way to monetize its service enough to generate a profit. Otherwise, all the growth in the world won't get Pandora any closer to perfection in the years ahead.

Keep searchingNo stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.